Divorces: Splitting up and then splitting stuff

Greg asksMy ex-wife and I both have defined benefit pension plans with the same company, however at the time of the dissolution of our 19-year marriage my income was 3 times hers and I had 22 years of pensionable service and she had 6 years. We have determined a valuation of all assets including the pensions and have settled and transferred all other assets 50/50. Should I agree to the transfer of the full amount owing as a pension credit transfer or should I be trying to protect as much of my pension as possible and finding other means to satisfy the settlement, ie. a cash settlement which I would have to go into significant debt to finance?

Jason Heath answers Splitting up with a spouse invariably means you need to come to an agreement on how to split your finances.

Depending upon your circumstances, this can include the family home, investment accounts, debts and ongoing support for each other and your children, among other things. Some things are often overlooked initially when people crunch the numbers in their heads and these include less tangible assets, like life insurance or pensions.

In Greg’s case, he needs to determine what to do with his company pension, so we’ll start there. His pension is no doubt more “valuable” than his wife’s, given more years of service and a higher income. But because it’s a defined benefit (DB) pension that will ultimately provide a monthly income, it’s not as easy to value as a defined contribution (DC) pension invested in mutual funds or another investment account that has a more easily defined value based on looking at the investments at a point in time.

DB pensions are typically valued based on what is known as a “commuted value,” or lump-sum value based on a number of assumptions. According to the Canadian Institute of Actuaries, “there is no simple ‘formula’ per se that will allow you to calculate the present value of a pension on your own.

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The key elements of the calculation – the terms of your pension plan, your personal situation and actuarial standards in effect at the time of the calculation – all get incorporated.” The calculation involves things like the age of you and your spouse, the assumed start date of your pension, whether the pension is indexed to inflation, pension legislation in your province and perhaps most importantly, interest rates.

So today’s low rates are good and bad, as I’ve alluded to in past articles. One thing they’re good for is for those who are receiving lump-sum commuted values from pensions, whether due to leaving a company pension or due to a marriage breakdown. For actuaries who calculate commuted values factor in today’s interest rates and while rates are low, this increases the lump-sum payment one would need to receive today in order to replicate a future pension’s payments.

However, in Greg’s case, being the payor of a potential lump-sum as opposed to the recipient, today’s low rates present a potentially negative outcome from writing a cheque today. I’d say even more so given his suggestion that he doesn’t have the savings to write such a cheque, meaning he’d be borrowing to do so.

This is a big decision that depends on a lot of other factors and for readers, no advice should be considered ‘one size fits all’

If I were Greg, I’d be more likely to consider a transfer of pension credits, meaning he would likely give away a portion of his years of service and these credits would be allocated to his wife’s pension instead. An actuary for the pension would determine how to adjust her pension entitlement accordingly.

That said, this is a big decision that depends on a lot of other factors and for readers, no advice should be considered ‘one size fits all.’ People often forget about the potential of splitting basic government pensions that most Canadians receive, like Canada Pension Plan (CPP) and Old Age Security (OAS) as part of a divorce. CPP entitlement tends to be more variable, based on the number of years and level of contributions, than OAS, which is based on years of residency in Canada. So agreeing to split CPP pensions in retirement as part of a marriage breakdown is common-place.

Life insurance often becomes part of the negotiation and settlement process as well, whether to protect future spousal support, child support, or simply as part of an eventual agreement.

The long and the short of it is that a divorce is much more than an emotional, lifestyle and moral decision. There are financial implications in the short and long run. There are no rules of thumb that help you make all the right decisions all the time, just like anything in the world of personal finance.

But one thing this happily married financial planner has seen through friends, family and clients is that working together is good for not only staying married, but also getting divorced. To the extent possible, it seems to be better to work together to help achieve the optimal outcome.

Jason Heath is a fee-only certified financial planner and income tax professional for Objective Financial Partners Inc. in Toronto.